There are almost as many buyout plans as there are accounting firms. However, there are two main buyout methods. These are based on revenues, average compensation, or possibly a combination of the two.
During some recent calls with readers, I heard about problems with the buyout based on revenues. Here are some of my views on this:
- Small practices typically can be sold, and the price is usually based on revenues. The definition of revenues and the measurement period, issues about client retention and guarantees, payout periods, deductibility and taxability of payments and the seller remaining for a period are all items that need to be negotiated when there is a sale. However, in a buyout of an existing partner’s interest, many of these are fully known, understood and taken as a given, or are covered in a buy-sell agreement.
- Usually it is the younger partners who buy out the older partners. Basing the buyout price on revenues creates a conundrum, as I see it.
- The natural order of progression usually has the older partners more interested in maintaining the base while the younger partners want to grow the practice, i.e., grow the revenue. However, each new client a younger partner brings in increases the price they will pay to the retiring partner. My discussions with younger partners indicate this is counterproductive to growth and creates a hesitancy by the younger partner to try to grow the practice as aggressively as they might like.
- Usually when younger partners are selected, one of the criteria is their ability to bring in business with the expectation of growth. However, it does increase the buyout amount. Regardless of everything else, it hinders efforts — possibly not overtly, but it’s a hindrance nevertheless.
- There are ways to deal with this. For instance, the revenue base could be set at a period three or so years before the buyout is to start, or an average of the previous three or more years’ revenues could be used. Alternatively, the payments could be spread over a longer period; a compensation bonus system could be adopted that would increase the current earnings of the person developing the new business; or a credit could be applied against the purchase price for new business brought in.
- Another alternative is for the practice to be sold to a third party using the most current revenues as the basis for the price. However, this would circumvent the premise of continuity that might have been a major reason for the younger partners remaining with the firm and establishing their career.
- While there seems to be an established percentage of revenues that a practice is worth on a sale, this is reduced by clients lost during the guarantee period, which usually doesn’t result when a partner retires since the remaining partners and staff are known to the clients and a smooth transition has been planned for.
- Further, in an arm’s length sale, adjustments to established percentages are made to take into account the quality of the clients, the ages of the owners, the types of clients, whether the firm charges subnormal fees, the extent to which the retiring or selling partners remain and on what basis and for what period, and the payment period and taxability of the payments. In a succession transfer, many of these are not a concern.
This issue is very important but is also involved and confusing and has many moving parts. Fairness is important as is good faith and an understanding that while one of the partners might be much older than the others, any partner could end up being a buyerorseller. Life brings with it surprises and occasional disappointments. Try to make a plan that is reasonable, workable and manageable by those who have to make the payments, and also assures the maximum possible growth in the practice.
Do not hesitate to contact me at
Edward Mendlowitz, CPA, is partner at
